Omicron and inflation fears put to bed, for now
The penultimate trading week of the year has been categorised by rapid price movements and large swings across financial markets, however the price action on Wednesday has been relatively peaceful with pockets of brightness, which is perfect for the season. Omicron, the changing monetary policy landscape and thin liquidity due to the Christmas holiday are all dominating markets, along with some better-than-expected US economic data, which we will discuss in more detail below. The FX market has been where the volatility has exploded, USD/TRY had a major reversal on Tuesday and Wednesday, falling from more than 18 to 12.50, where it has settled for now. Overall, we still have not given up hope of a Santa rally as we move closer to the Christmas festivities.
Small signs that Omicron could be less of a threat than feared
The big news on Wednesday is that the UK is reporting some encouraging signs about the severity of the Omicron Covid variant. A Scottish study suggested that early national data suggest that Omicron is associated with a two-thirds reduction in the risk of hospitalisation compared to the Delta variant, and that a booster shot is associated with considerable added protection against symptomatic disease when compared to people with only two doses of the Covid vaccines, and especially those who are unvaccinated. This study has yet to be peer reviewed and is based on a tiny sample of 15 people who tested positive for the Omicron Covid variant. Thus, there is still the possibility that Omicron could be worse than what this study suggests. However, the media is running with this study, and it is having a positive effect on risk sentiment as we move into the second half of the week. While Omicron has led to some travel restrictions and lockdowns in parts of Europe, if Omicron is able to pass without too much pressure on health services, then lockdowns and economic damage could be avoided in the long term, even if in the short-term rapid infection rates and mass isolations could impact economic growth particularly in the UK, Europe and in the US, now that Omicron is the dominant variant. While this could impact Q4 growth figures, signs that Omicron is less of a threat tour health services is good news for the Q1 growth outlook.
Inflation could be peaking
As we mention above, there are two key drivers for markets right now: Omicron and central bank policy, and we had good news on both of these on Wednesday. Omicron may not be as bad as initially feared, and in the US, the Conference Board Consumer Confidence report rose to 115.8 up from 111.9 last month. This immediately boosted US indices, and unsurprisingly, the consumer discretionary sector is leading the S&P 500 on Wednesday. The increase in confidence was driven by positive expectations for the future. The US consumer is more optimistic about the short-term outlook for income, business and labour market conditions. The proportion of US consumers prepared to purchase homes, cars, major appliances and vacations also rose, which is also positive for US growth in the future. Crucially, inflation expectations, which had risen to a 13-year high last month, fell back, which could suggest that inflation expectations may be plateauing. While it is too early to call an end to this inflation cycle, in our view, we think that this data highlights the fact that consecutive months of rising prices and multi-decade highs for annual price increases may start to recede in the first few months of 2022. Thus, we could be past the peak of eye-wateringly high inflation rates, which is good for the US economy and for corporate profit growth.
Fed Rate hikxiety reduced
If inflation does ease off in the first few months’ of 2022, as we expect, then it could make it easier to determine monetary policy, particularly in the US. While the Bank of England has already hiked interest rates, there was some uncertainty as to the timing of the first rate hike from the Federal Reserve. If, and it’s a big if, the Conference Board Consumer Sentiment inflation expectations component is a sign that the pace of inflation starts to fall in the coming months, then it makes a rate hike in mid-2022 from the Fed more likely, and it reduces the chance of a hike earlier in the year. Thus, this latest piece of economic data from the US could reduce Fed rate hike anxiety as we move towards the end of the year, which may be enough to trigger a very late in the day Santa rally.
Our top picks for a Santa rally:
1, Airlines and tourism: if omicron fears have been overdone, then airlines, cruise operators and hotel chains should outperform. In the UK on Wednesday IAG, the parent of British Airways, was a top performer up more than 3%. US airlines were also higher, including American Airlines, which rose more than 1%.
2, Consumer discretionary: it was unsurprising to us that Tesla, the electric vehicle behemoth, was up more than 6% on Wednesday. This large move higher on Wednesday came after Tesla founder and CEO, Elon Musk, said that he had now sold enough stock. However, if US consumers are looking to buy cars next year, and a large portion of these purchases are electric vehicles, then you can be sure that Tesla will feature. Thus, Wednesday’s move could boost momentum for this stock, technical indicators are pointing to a fresh buy signal for Tesla after it broke above the 15/12 high, and there could be more upside for Tesla if there is a Santa rally into year end.
3, The Dax: We like the German index for two reasons. Firstly, we think that the new German government will loosen the fiscal screws as it spends its way out of the Covid crisis and as it prepares to implement a new green energy agenda. More fiscal spending is good news for German stocks. Added to that, two German car makers, Daimler and VW, should be at the forefront of the electric vehicle push and is likely to take market share away from Tesla in the coming years. Added to this, one of our conviction trades is for a weaker euro next year, partly down to the new Bundesbank chief, who we believe is a closet dove. If the Bundesbank stops being the hawkish outlier at the ECB, then we think that sovereign spreads with the US will continue to weaken, which should make the euro less attractive. A weaker euro should be good news for German stocks and a rally may start this side of the new year.
4, USD/TRY: news on Tuesday that President Erdogan has launched a new savings initiative to compensate savers for exchange rate losses, and halt the outflow of money from Turkey, is a dangerous move in the long term. While it had the immediate effect of sending USD/TRY southward from above 18 to 12.50, we think that the lira will struggle to make gains from now on. The new savings scheme is essentially an interest rate increase by stealth; however, taxpayers are financing the wealthy savers of Turkey. While Turkey has relatively strong public finances, this move is a costly alternative to a straight-forward interest rate hike, something that should have been done months ago to ward off surging rates of inflation and to try and prop up the ailing currency. Instead, the government is trying to do the job of the FX market to save face for President Erdogan. Unless there is an actual interest rate hike in the coming months, then we don’t see the latest move by President Erdogan as being enough to support the TRY recovery in the long term.
Merry Christmas everyone, and don’t forget to look out for our 2022 top picks that will be out very soon!